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If you inherit a Roth individual retirement arrangement (Roth IRA) from a parent and take withdrawals correctly, you’ll be able to enjoy tax-free withdrawals for years. Your options will depend on whether you are considered a designated beneficiary or eligible designated beneficiary.
Learn more about these designations and what to do when you inherit a Roth IRA in different circumstances.
Key Takeaways
- You must withdraw all of the money from a Roth IRA that you inherit from a parent.
- You can take the money in a lump sum or in smaller withdrawals.
- You can keep the money or deposit it into an inherited IRA account, but you cannot move it to a Roth IRA.
- In most cases, withdrawals will be tax free.
Your Roth IRA Options
If you are a beneficiary inheriting a Roth IRA, you must follow differ rules depending on your circumstances. If the IRA originally belonged to your parent, you fall into one of two categories: designated beneficiary or eligible designated beneficiary.
What Is a Designated Beneficiary?
Designated beneficiary applies to most people who inherit an IRA from a parent. Also called a “named beneficiary,” is defined by the SECURE Act as someone designated to receive an asset when the original owner dies.
If you are a designated beneficiary on your parent’s IRA, you will be required to withdraw all of the money from the account within the 10-year period following your parent’s death. This period starts December 31 the year after the original account owner died. This is sometimes referred to as the “10-year rule.”
However, you have flexibility with when you take out money and how much you take out each withdrawal before the 10-year period is over. You do not have to take required minimum distributions (RMDs) every year, but you can make withdrawals whenever you like—just as long as you deplete the account within the 10 years.
In the meantime, if you don’t need the money, you can keep it invested in the IRA and enjoy another decade of tax-free growth.
Note
With traditional IRAs, you can take a tax deduction the year you make the deposit. When you withdraw the funds, you will then pay income tax. With Roth IRAs, you deposit funds after they’ve been taxed. The tax advantage with Roth IRAs is then when you make the withdrawals, which you can do tax-free.
What Is an Eligible Designated Beneficiary?
The eligible designated beneficiary category applies to minor children (the age of majority varies by state), a surviving spouse, and individuals who are disabled or chronically ill.
Minors can begin to take distributions over their remaining life expectancy, as determined by the tables in Publication 590-B of the Internal Revenue Service (IRS), until they reach the age of majority. (Generally, anyone up to age 26 may be considered a minor.) After that, beneficiaries must follow the 10-year rule in which they must withdraw funds within 10 years. But they are not required to take RMDs.
Others in the eligible designated beneficiary category can simply take distributions over their IRS-determined life expectancy.
These more flexible rules give eligible designated beneficiaries an opportunity to stretch their distributions over a longer time period and thus benefit from the Roth IRA’s tax-free compounding for that extended period. However, eligible designated beneficiaries are not obligated to do that—they can take distributions as soon as they like, even right away in the form of a lump sum. As long as the account that they inherited satisfies the five-year holding period rule, their distributions will be tax free.
Important
Consider consulting a professional financial advisor to review your options for the funds from an IRA you inherit. The best strategy for you will depend on you financial situation.
Opening an Inherited IRA Account
If you inherit a parent’s IRA—either Roth or traditional—you will need to decide how you will accept the money. One option is to take the money in a lump sum.
If you want to maintain the account’s tax advantages, you can open an inherited IRA, which is sometimes called a beneficiary IRA, and move the money into it. You can do that at many financial institutions that handle regular IRAs. Unfortunately, you will not be able to contribute additional money to your inherited IRA.
How Inherited Roth IRAs Are Taxed
The money in an inherited IRA will continue to grow tax-free as long as it remains in the account. Distributions of the original account owner’s contributions aren’t taxed, but distributions of earnings are taxable if the Roth IRA or any other Roth IRA held by that same account owner is not at least five years old. Inherited IRAs are not subject to the 10% penalty that is normally imposed on account holders who take distributions before age 59½.
Frequently Asked Questions (FAQs)
How Does the Internal Revenue Service (IRS) Define ‘Child’?
Under federal law, a child is the son, daughter, stepson, stepdaughter, legally adopted child, or eligible foster child of the taxpayer.
Can an IRA Have More Than One Beneficiary?
An IRA can have more than one beneficiary. When the original account owner dies, each beneficiary should set up their own inherited IRA with their portion of the account funds.
What Happens if I Don’t Take Required Minimum Distributions (RMDs)?
Individual retirement account (IRA) holders who don’t take required minimum distributions (RMDs) on schedule can be subject to an excess accumulation penalty, which is a 25% tax on the difference between the amount that they should have taken as a distribution and the amount (if any) that they actually took.
For an account whose original owner died in 2020 or later, the deadline for emptying an inherited Roth IRA is generally Dec. 31 of the tenth year after the original owner’s death. Some additional rules apply to a spousal beneficiary. And the liquidation deadline can vary, depending on whether the original owner started to take RMDs.
The Internal Revenue Service (IRS) says it can waive all or part of the penalty “if you can show that any shortfall in the amount of distributions was due to reasonable error and you are taking reasonable steps to remedy the shortfall.”
The Bottom Line
Children who inherit a parent’s Roth IRA eventually will have to take all of the money out of the account. The rules differ depending on whether they are classified as a designated beneficiary or an eligible designated beneficiary. Either way, if they handle the account properly, then all of their distributions will be tax free. The rules on inheriting an IRA can be complex, so consider consulting a financial professional for more guidance.
